A Race to the Bottom

Just about every major developed nation is struggling to continue its growth. Countries in Europe are struggling even more so now with all the austerity measures they have implemented to reduce their debt, Japan hasn’t whiffed a scent of growth for two decades now, the U.S. is barely growing, AND that is with all the unprecedented "stimulus" that has been provided by the U.S. government and Federal Reserve.

It’s quite clear that all of these economies are now overstretched, and there simply isn’t enough political will, or for that matter money, to try to sustainably stimulate these economies. All the policy prescriptions that have been provided have largely been temporary band-aids which did very little to improve our structural employment problems. As I have always argued, structural problems require a structural solution which is why the Obama administration’s remedies have for the most part all come up short .

So this leaves the Federal Reserve, and they understand, or should I say they believe, that they are the last beacon of hope. We’ve addressed this topic in our INFLATION THROUGH DEFLATION (http://www.gold-observer.com/newsletter/9-Inflation_Through_Deflation ) newsletter, where we forecast that the Federal Reserve would continue another round of QE sometime during the second half of this year. I’m sure some of you have heard this QE acronym but perhaps you may be unaware of it. Basically in a nutshell, it means that the Federal Reserve will print money to try to artificially stimulate the economy. The idea is to bring down interest rates for mortgages, auto and business loans, and to flood the banks with cash so that they will lend it in order to stimulate the economy. Sounds good, the problem is that rates are already at record lows, banks have more cash than they’ve ever had , and corporations are sitting on a record $1.8 Trillion. So the issue isn’t that the cost of capital is too high, it’s that there is a lack of sustained domestic demand for goods and services, too much restrictive nonsensical populist regulation imposed by the government, lack of credit-worthy borrowers, and a continuing deterioration of RE assets sitting on the banks balance sheets that were never addressed in the flawed big bank bailouts of 2008.

In any case, the Federal Reserve will push through with another round of QE, which they now are dubbing it as QE2. The word on the street is that it will be approximately $1 Trillion dollars. Remember folks, they’ve already printed $1.4 Trillion in the first round of QE back in 2009, so this would now push it up to close to $2.5 Trillion. So what are some of the possible and likely side-effects of printing such a massive amount of money? I mean, you can’t just keep printing money without side-effects, right? If there were no consequences then the Federal Reserve could print $10 Trillion and send everyone checks for $200,000 and life would be just lovely . The reality is that these actions do come with a price tag and that price tag is a weaker dollar and future inflation.

However, there is a positive consequence to weakening the dollar and it does actually structurally help solve part of labor market problems. We all know that growth in the developed economies such as Europe, Japan and the U.S. is virtually non-existent, but there is very strong growth in the emerging market economies such as Brazil, Russia, India and China, and it’s not just limited to them; the Middle East is growing with those impressive oil revenues and just about all the extension economies of Asia and Latin America are growing as well. So one of the best ways for the developed nations to grow is to cater to the needs of the Emerging market economies. These economies are growing and they are growing fast, and they demand goods and services. If countries like Japan, Germany, and the U.S. can manufacture goods and ship them out to these countries then that will help them grow, which in turn would produce more Jobs. That’s what it all comes down to folks; JOBS JOBS JOBS. Even our community organizer, oops, I meant to say president, understands this when he recently said "The more American companies export, the more they produce, and the more they produce, the more people they hire, and that means more jobs -- good jobs that often pay as much as 15 percent more than average."

One of the best ways that each of these respective economies can compete with one another is to devalue their currency. If the value of the dollar becomes worth less , then that means if a country like China wants to buy our goods it would make it cheaper for them to do so. Sounds like a good strategy; the problem is that we aren’t the only ones who realize this. Every Central bank understands this, which is why you are seeing England institute QE policies as the Euro recently embarked on QE as well and now Japan for the first time in six years decided to intervene in their currency markets to push down the Japanese Yen. Over the past few years they have all complained of how they believed their currency was too high relative to others. Of course this affects their exports and since everyone realizes that there is little hope to grow domestically they are all desperate for this competitive advantage.

Not only does this QE and currency devaluation strategy help stimulate exports but it also allows them to inflate their way out of debt. If you as a country have a national debt of $10 Trillion and all of a sudden over a period of a few years your policies devalue the currency by 30% then that would mean that you would tangibly only have to pay back 70% of your debt. Once again, sounds good, but those who get screwed are the ones who were buying their debt because they would now be left with their battered currency, and of course it hurts every single consumer on the planet , especially lower to middle income earners, because that means everything they buy will become more expensive. Understanding that, this artificially induced inflation that was produced from the Federal Reserve will not only hurt U.S. consumers but in fact in means we will export inflation overseas and would have a considerably larger impact on developing economies such as China where daily incomes on average are only a few dollars a day, and when oil and food prices rise, then it really takes a much larger bite out of their disposable income. Ouch!!!

The signs of inflation are already beginning to show up; I know that the Federal Reserve and some of the CNBC cheerleaders will tell you that there is no inflation. HAAAA! Gasoline is in the neighborhood of $3 a gallon, grains such as corn, soybeans and wheat are at multi-year highs, cotton is going through the roof, soft commodities such as coffee, cocoa and orange juice are soaring, copper is beginning to bust out, and gold is at record highs. Meanwhile this is all happening with the real unemployment rate hovering around 17%; YIKES!!! Yeah ok, there’s no inflation, pfffft.

I am here to tell you, that this is what you should expect A Race to the Bottom…, you should expect to see central banks across the developed nations continue policies that will devalue their respective currencies and that you will surely see a weaker Euro, weaker British Pound, weaker Yen, and most importantly, a weaker Dollar relative to finished products, commodities, and services. As I always say, as the value of paper currencies go down, alternate currencies such as gold goes up. As I’m writing this, gold has topped $1300.an oz., and by the time this multi-year run is over I truly believe you will see gold well over $3000.an oz.

Matthew Goldfuss

gold-observer.com

Matthew Goldfuss is a Gold, Silver, and precious metals representative with eight (8) years experience. He has worked in one of the top companies of its kind in the field during that time and has achieved a high level of competence and expertise.